Canadians have about $1.5 trillion invested in mutual funds. Perhaps you yourself have purchased mutual funds from a financial advisor, bank branch, or as part of a retirement savings program at work.
Mutual funds have been the dominant investment option for many years, but ETFs are starting to take over. Today, about 22 cents out of every investment dollar in Canada go to ETFs, according to data from National Bank Financial. What’s happening? It might help to start with a brief history of investing.
Throughout most of the 20th century, stock market investing was something only rich people did. They would hire stockbrokers to analyze which stocks and bonds to buy or sell. The client would pay a commission on every transaction.
This approach probably worked OK at a certain time. The world was a simpler place, and a savvy stockbroker could probably pick a promising oil company or railway concern to invest in. The clients were paying a ton in commissions, but they were rich and the stock market was an exclusive club, so no one really seemed to mind.
Around the 1960s, a little-known investment concept started to gain popularity. Mutual funds were created by pooling the money of thousands of not-necessarily-rich people together, so that a “super-stockbroker,” known as a Portfolio Manager, could manage it for them en masse.
The clients would be charged the usual trading commissions, plus a portfolio management fee. These fees were no joke – they could add up to hundreds of thousands of dollars over a client’s lifetime.
Despite the high costs, mutual funds really took off in the 80s and 90s. Markets were booming, so the fees weren’t really noticed or challenged. Billions of dollars flowed into the funds. Regular people made money, and mutual fund companies made absolute fortunes.
However, somewhere in the early 2000s, things started to change. The dot-com bubble, Enron scandal, and financial crisis meant stock market returns were no longer as easy to come by. People started to compare what mutual funds were charging versus the returns they were generating, and it was clear that something wasn’t adding up.
More than a century after the iconic Dow Jones Industrial Average was created, Wall Street was starting to look like a myth. The data showed that, almost without exception, investors could have done just as well by purchasing one share of every company, then by paying high-priced experts to try to pick winners.
It turned out that, over time, the fees that the experts charged tended to be exactly the same amount by which their clients would come up short.
Let me explain: Say the Dow, which tracks 30 of the largest companies in America, went up by 10%. You could have bought all 30 stocks and made 10%. Alternatively, you could have paid a mutual fund manager 2.25% to try to beat the Dow, but statistically, they will have ended up with the same 10% return. The catch is you would have only kept 7.75% after fees.
Yes, there are exceptions. Sometimes mutual fund managers have stellar years. Some may have two or three great years in a row. But it’s impossible to predict which manager will outperform in any given year, and none have been able to sustain a lasting edge according to the current body of research.
Exchange-Traded Funds, or ETFs, are built on this insight. Rather than trying to select winning stocks, they aim to represent all of the stocks in a given market. And rather than charging Rolls Royce-level fees, they aim to keep costs to a minimum – just a small fraction of mutual fund fees.
Here’s everything you need to know at a glance:
|Structure||You purchase units of a mutual fund along with many other investors. A Portfolio Manager attempts to pick winning stocks or bonds.||You purchase shares of an ETF on the stock exchange. Each share represents an underlying index, such as the S&P 500 for U.S. stocks or the S&P/TSX for Canadian ones.|
|Fees||The average Canadian Equity mutual fund charges 2.25% per year.||The average Canadian Equity ETF charges 0.22% per year.|
|Result||Research shows that mutual funds can cost the average Canadian family $300,000+ in extra fees.||The money you save with ETFs can make it easier to sustain your lifestyle now and in retirement.|
In our opinion, ETFs are simply a far better value for your money. Perhaps Warren Buffett, one of the world’s wealthiest men, said it best when he gave this instruction to trustees of his multi-billion dollar estate:
“My advice to the trustee couldn’t be more simple: Put 10% in short-term government bonds and 90% in a very low-cost S&P 500 index fund [similar to an ETF]. I believe the trust’s long-term results from this policy will be superior to those attained by most investors — whether pension funds, institutions or individuals — who employ high-fee managers.”